fx survey summary 2011

8/12/2019 FX Survey Summary 2011

1/25

Foreign Exchange

Risk Management Practices Survey


2/25 | Foreign Exchange Risk Management Practices Survey wellsfargo.com

Foreign Exchange

Risk Management Practices SurveyPrepared by: Wells Fargo Foreign Exchange

Wells Fargo Foreign Exchange is pleased to release the summary findings

of our Foreign Exchange Risk Management Practices Survey conducted

from January to February , . The purpose of the survey is to

gather information about FX risk management practices and policies

from a representative sample of our foreign exchange customer base. This

information, in turn, can provide you with a benchmark measure of how your

peers are addressing foreign exchange risks.

This survey represents the third time in four years in which Wells Fargo

Foreign Exchange has obtained information about FX risk management

practices from a broad cross-section of our customer base. The years

and provided a close comparison of practices and trends separated by

a single year. With our survey, we add to the composite picture of riskmanagement practices. In most instances, the practices that we observed from

the first two surveys have been reinforced by our third profile of respondents.

This theme will recur throughout our summary findings.

This series of surveys is distinguished by a significant turnover of participants

from year to year. We believe that the cumulative feedback of so many unique

respondents, reflecting a critical mass of viewpoints, provides results that are

highly reflective of the state of FX risk management in corporate America today.



Table of contents

uExecutive summary

The current risk management environment ........................................................................

Risk management objectives .........................................................................................................

Exposures hedged ................................................................................................................................

Hedging instruments ........................................................................................................................

Foreign exchange policy .................................................................................................................

Hedging strategy .................................................................................................................................

Risk management challenges ......................................................................................................

uSurvey participants

uRisk management practices

Management of FX exposures......................................................................................................

Risk management objectives .........................................................................................................

Formal FX risk management policy .......................................................................................

Counterparty credit ratings .........................................................................................................

Budget rates ...........................................................................................................................................

Attitude toward risk management ...........................................................................................

uFX exposures

Booked foreign currency assets or liabilities ...................................................................

Forecasted foreign currency revenues or expenses ......................................................

Translated net income from foreign subsidiaries and ................................................

net investments in foreign subsidiaries

uHedging practices: Balance sheet hedges

Percent of balance sheet positions hedged .......................................................................

Maturities of balance sheet hedges ........................................................................................

Balance sheet hedge instruments ............................................................................................

Hedge accounting election for balance sheet hedges ................................................

uHedging practices: Forecasted transactions

Percent of forecasted transactions hedged .........................................................................

Maturities of forecasted transactions .................................................................................... Layered hedge program for forecasted transactions ...................................................

Forecasted transaction hedge instruments .......................................................................

Hedge accounting election for forecasted transactions ...........................................



uTranslated net income from foreign subsidiaries and

net investments in foreign subsidiaries

uAdditional risk management practices

Accounting conventions ...............................................................................................................

Risk management approach .......................................................................................................

Providing a budget for hedging ...............................................................................................

Centralized risk management ....................................................................................................

uBiggest challenges related to FX risk management

Accuracy and timeliness of exposures and forecasts ..................................................

Market volatility, when to hedge, and using the proper strategy ........................

Approvals, communications, and internal resources ..................................................

Hedge accounting and compliance ........................................................................................

uSummary and conclusion



Executive summary

uThe current risk management environment

While market conditions have stabilized from the financial turmoil of

and , of respondents stated that foreign exchange

became of greater concern to them in the past twelve months.

For those who expressed greater concern, increased the amount

of exposure being hedged.

uRisk management objectives

As was the case in , companies rank eliminating FX gains andlosses as their most important risk management objective.

uExposures hedged

A majority () of companies actively hedge foreign currency

balance sheet positions that affect foreign exchange profit and loss

results and realized cash flows.

Between and , behavior toward hedging future business

activities stabilized. Among companies that recognize forecasted

foreign currency revenues and expenses as exposures, employ

derivative hedges to manage the economic impact of these

exposures. In , hedged forecasted transactions.



uHedging instruments

Use of forward contracts remains a prevalent practice.

About one-third of companies use options to hedge balance sheet

exposures and use options to hedge forecasted transactions.

In order to manage earnings more effectively, hedge accounting

under FAS (ASC , but referred to throughout by its original

name) is employed more frequently by public firms with larger

revenues, as compared to private and/or smaller revenue companies.

Of the companies that hedge forecasted transactions, hedge

exposures with maturities of twelve months or longer.

uForeign exchange policy

The existence of a formal written policy for managing foreign

exchange increased marginally in () from ().

Companies with policies have become more attentive to counterparty

credit risk. Those with a specified minimum credit rating for

counterparty risk increased to from in both of the prior surveys.

uHedging strategy

Systematic risk management, identified by of respondents, isthe predominant style for managing FX risk. The percentages for

the style described as active hedging increased somewhat from the

prior studies. The prevalence of dynamic hedging remains

basically unchanged.

Most companies () manage risk on a centralized basis, with

larger, public companies most likely to do so.

uRisk management challenges

The most often cited risk management challenge facing companiesis understanding, identifying, and quantifying exposures.

Most companies () set budget rates as part of their formal

planning process, but the process used for determining a budget

rate is highly variable.



Survey participants

The respondents to this survey represent a broad cross-section of companiesin the Wells Fargo customer base employing risk management techniques tocontrol their FX exposures. The array of respondents was spread evenly from

very small businesses (annual revenues less than million) to the largecorporate marketplace (annual revenues greater than billion).

As was the case for the survey, this survey represents practices of bothprivate and public corporations. The percentages from these sectors are thesame for and : of responses were from private entities and from public companies. Also, both surveys drew of respondents fromcompanies based in the United States, and of respondents indicated thatthey have foreign subsidiaries. Finally, the preponderance () of repliescame from companies in the manufacturing, wholesale trade, and technologyfields, with additional representative responses from several other industries.

The survey is the third FX risk management survey conducted by Wells FargoForeign Exchange in the last four years. The prior two surveys were from and . We noted in that of the respondents to the survey werenew respondents. In other words, they had not responded to the survey.We noted further that in many respects, the responses from were verysimilar to .

This year, of respondents are new responders to the survey, meaningthat a substantially new base of companies described their risk managementpractices that were not included in the prior survey. In most instances, the responses were similar to the survey. It, in turn, as noted above, hadresponses similar to the survey. Taken together, these three surveys all with similar results present increasingly robust findings about the state ofFX risk management over the four-year time span. Indeed, when assessed as awhole, we received total responses to these three surveys, with uniqueentities responding to one or more in order to aggregate the total.

We believe that the combination of so many unique respondents producingsuch similar results for each of the three surveys paints a highly reliable profileof how companies are managing risk. While our initial instinct is to lookfor emerging trends in risk management, trending outcomes have not beenparticularly notable. Instead, what has been striking is the stability of riskmanagement practices over a four-year time span. By obtaining similar resultsin successive surveys, each survey has reinforced the validity of the priorresults because the turnover of respondents has been so substantial.

Parent company based

U.S.

Abroad

Have foreign subsidiaries

Yes

No

Company annual revenue

Less than million

million - million

million - million

million - million

million - billion

billion - billion

Greater than billion

Industry

Manufacturing

Wholesale trade

Technology

Retail

Finance, insurance, RE

Construction

Healthcare

Education

Non Profit/government

Other



Risk management practices

Management of FX exposures

At the highest level of inquiry in the survey, of respondents stated that theyhave exposure to trade related or financing related non-functional currency

exposures. The survey targeted behaviors in these two areas because in ourexperience, most companies that actively manage or hedge foreign exchangeexposures are affected primarily by ongoing activities in these categories.Those who indicated that they do not have exposure in either area generallycome from industry groupings such as government, education, and health care,where commercial activities may involve foreign exchange, but do not requirethe same hedging and risk management needs as most respondents from themanufacturing, wholesale trade, and technology sectors.

Risk management objectives

Foreign exchange risk can affect a companys operations in a number of ways.In order to measure at a high level, the most important risk management

objectives among companies, we asked respondents to rank five variablesfrom most to least important. The most important objective was to eliminateFX gains and losses, with of respondents ranking this first. The next mostimportant objective was to minimize earnings volatility, with ranking thisfirst. When first and second rankings are added together for each objective,minimizing earnings volatility at a sum of becomes the most importantobjective, followed by eliminating FX gains and losses at .

Importance of risk management objectives

Eliminate FX gains/losses

Minimize earningsvolatility

Optimize U.S. dollarcash flow

Protect budget rate

Maintain competitiveadvantage

Ranked first Second Third Fourth Ranked last

Eliminating gains andlosses and minimizingearnings volatility are mostoften ranked one or two inorder of importance.



Analyzing the data more finely for distinctions between public and privatefirms reveals some interesting nuances. The top priority for public firms isto minimize earnings volatility, with rating this their primary goal. In

addition, of public companies stated that this objective was their secondmost important priority. With just over two-thirds of public companies ratingthis objective their top or second priority, it reinforces how much importancepublic companies place on their reported earnings.

Importance of risk management objectives: Public



Optimize U.S. dollar cash flow

Protect budget rate



In contrast, the most important objective for private companies is to eliminateFX gains and losses, with of respondents giving this objective a numberone ranking. When including those companies that ranked this as the secondmost important objective, the total percentage of a one or two rating grows toa total of . In the private world, reported earnings are less important sincethey do not need to be reported to a broad base of shareholders.

Importance of risk management objectives: Private



Optimize U.S. dollarcash flow

Protect budget rate



It is also interesting that of private companies rated maintaining acompetitive advantage either one or two in their rankings, whereas only of public firms rated this objective (ranked lowest overall) that high in theirrankings. While not a huge difference, the data suggests that private firms aremore sensitive to competitive issues in their markets. It is worth noting herethat among our respondents, of public companies had revenues of greaterthan million, while only of private companies exceeded that levelof revenue. This fact further strengthens the inference that private companiesmay need to be more nimble to maintain a competitive advantage if they lack acritical mass of market penetration in their particular industry or service.



Formal FX risk management policy

Overall, of respondents stated that they have a formal written policyfor managing foreign exchange. While not a huge change, this figure is an

increase from a result in . Eighty percent of public companiesreported having formal policies, while only of private companiesresponded in the affirmative. Likewise, larger companies, with revenuein excess of million, are more likely to have formal policies, as meeting this revenue criteria stated they have an FX policy. Conversely, only of companies with revenues of less than million have a policy.Our continuing conclusion is that public companies, more accustomed to aSarbanes-Oxley controls environment and additional public scrutiny, are morelikely to implement formal policies that describe the responsibilities for FXrisk management and establish appropriate controls and authority for suchactions. Nonetheless, we remain surprised that having a formal policy is notmore prevalent.

Counterparty credit ratings

With respect to counterparty credit ratings, of respondents indicatedthat they specify a minimum credit rating for counterparty exposure. Thisis an increase from , when the result was . Once again, publiccompanies are considerably more vigilant about the credit quality of theirdealing counterparties, with responses of and for public and privateentities, respectively. In , when of respondents said they maintainedminimum levels for counterparty credit ratings, we speculated that the strainsin the financial market that were becoming prevalent would provoke increasedvigilance with respect to minimal levels of counterparty credit ratings. Sincethen, behavior, while somewhat more prevalent for providing counterpartycredit limits, has not changed dramatically. Therefore, we continue to believe

that establishing minimal levels for counterparty credit ratings remains anarea for increased attention in the corporate community.

Have a formal written policy

Public

Private

million

million

Minimum credit rating forcounterparties

Public

Private

million

million



Budget rates

The survey indicates that of companies set budget rates as part oftheir formal planning process for managing FX risk. This outcome is down

substantially from an outcome in and an response rate in .Unlike previous surveys in which there was little variation in behavior aboutbudget rates when comparing public and private as well as large and smallrevenue companies, saw some differences. Public companies use budgetrates at an response rate versus only for private companies. Largecompanies responded at an rate versus a rate for small companies.While these measurements changed, the customary variability characterizinghow budget rates are set persisted in this survey.

This range of practices reveals that there is little consensus about the methodused to set budget rates. Using consensus forecasted rates continues to be thepreferred approach, selected by of respondents, which is up from in, but marginally lower from a response rate in . The Wells Fargo

recommended method for setting budget rates using prevailing forwardrates increased in to from last year, and from only in .However, using prevailing forward rates still trails consensus forecasted ratesand prevailing spot rates as a method when setting a budget rate.

Attitude toward risk management

In an effort to take the pulse of the market about the overall concern towardinternational exposures, the survey asked companies to rate whether inthe last twelve months their attitude toward foreign exchange risk managementwas a reduced concern, unchanged, or of greater concern. A majority, , statedtheir attitude was unchanged. A decided minority, , replied that their concernhad actually become reduced. But more than a third stated that foreign

exchange risk management had become a greater concern.

We asked those expressing a greater concern to characterize how they havechanged their behavior. Most () stated that they had increased the amountof their exposure being hedged. The next most often cited responses were todevelop or revise an FX policy () and to extend the average maturity oftheir hedges (). A smaller percentage of companies () responded bydecreasing the amount of exposures hedged and stated that they shortenedthe average maturity of their hedges. Overall, these results suggest thatFX risk management continues to evolve at many companies, an outcomeconsistent with increased international opportunities as the global economyrecovers from recession and a flat world heightens competitive pressures.

Source of budget rate

Consensus

forecasted rates

Prevailing

spot rates

Prevailing

forward rates

Historical

average rates

Other



FX exposures

The Risk Management Survey replicated a methodology introduced inthe survey to gather information about corporate behaviors. Specifically,both surveys sought to profile specific corporate foreign exchange behaviorsby concentrating on two high-level categories of exposure: ) transactionalexposure and ) translational exposure. Within each of these categories, therewere further distinctions to explore.

Transactional exposure was comprised of two sub-levels: ) trade relatedexposures that give rise to non-functional currency trade accounts receivableand/or payable and ) financing related exposures that give rise to interest-bearing non-functional currency assets and/or liabilities.

Translational exposure was comprised of two sub-levels: ) translation of aforeign currency functional subsidiarys income statement and ) translationof a foreign currency functional subsidiarys balance sheet, both for thepurpose of presenting consolidated financial statements at the parent level.

Booked foreign currency assets or liabilities

From the survey data, of respondents indicated they had exposure totrade related accounts receivable and payable, and acknowledged theexistence of interest-bearing, non-functional currency assets or liabilities.These exposures are often referred to in a short-hand manner as foreigncurrency balance sheet positions. The sum of the percentages exceeds because some companies have both exposures. Since of respondentsacknowledged exposure to neither, it may be inferred that of the surveyrespondents had exposure to this category of risk. Entities acknowledgingthe presence of neither exposure generally came from industry groupingssuch as government, education, and health care, where exposure to currencyrisk typically arises on an ad hoc basis, such as the need to fund internationalresearch or educational programs.



Forecasted foreign currency revenues or expenses

The methodology of the survey assumes that the same of respondentswho acknowledged they have exposure to trade related accounts receivable

and payable also have exposure to forecasted foreign currency revenuesand expenses. Our logic is that any company with ongoing transactionsthat generate foreign currency settlements would also be affected by futurerate movements that could alter the terms of trade. In the broadest terms,forecasted revenues or expenses denominated in a foreign currency representeconomic exposure to the currency markets, reflecting the potential forrevenues or expenses to be affected either positively or adversely by future,unpredictable exchange rate movements.

Translated net income from foreign subsidiaries and net investments

in foreign subsidiaries

To explore practices with respect to these translation exposures, the survey

first identified the universe of respondents with foreign subsidiaries. As wasthe case in our last survey, roughly three in four respondents () indicatedthat they had at least one foreign subsidiary as a result of their internationaloperations. A large majority indicated that the functional currency of thesubsidiaries is the local or foreign currency. This figure was well in excessof for the most frequently cited geographic regions. Thus, by definition,when following US GAAP, the existence of these subsidiaries would mean thatconsolidated financial statement results would be affected by FX rate volatilityand its effects on the translation of foreign subsidiary income statements andbalance sheets.



Hedging practices: Balance sheet hedges

Of the respondents who identified booked foreign currency monetary assetsand liabilities as an exposure on their balance sheets, acknowledged thatthey actively manage the exposure. There were no notable differences between

the behaviors of private and public companies, or by revenue size of companies.This outcome reflects almost unchanged behavior from , when statedthat they managed this exposure. The highest level of activity came from ,when hedged this exposure. We have consistently expressed mild surprisethat the percentage of companies actively managing this exposure is nothigher. The P&L resulting from the remeasurement of booked foreign currencyaccounts receivable and payable is typically captured in an FX Gain/Loss lineof the income statement. Explaining gains and losses attributable to FX P&Lis something that management usually seeks to avoid, since FX P&L , whethera gain or a loss, often calls into question whether risk management practiceshave been adequately defined. Regardless of our reaction, the three surveystaken as a whole reveal that a strong majority of companies hedge balance sheetexposures, but by no means is it a universal practice.

Percent of balance sheet positions hedged

With respect to the amount of the exposure hedged, the results form abit of a barbell distribution, with less than and more than beingthe most heavily cited practices. Once again, behavior among customersegments as distinguished between public and private and small and largerevenue customers did not reflect any special patterns. Practices were quiteconsistent across the board. The strongest point of contrast would be thatpublic companies and larger companies are more likely to hedge a greaterpercentage of their exposures. The results for hedging or more of balancesheet exposures were and for public and private firms, respectively.Similarly, and applied to firms with revenues greater than

million and less than million.

Results from both years indicate that companies in general are cautiousabout hedging this exposure. In the survey, only of companieshedged more than of balance sheet positions. In , the outcome grewmarginally to . The result was the lowest of the three surveys.We have been surprised that a larger portion of the exposure is not hedged,since theoretically, these are known and booked positions. An ongoing themefrom the surveys, however, is the uncertainty around measuring exposures. Inour surveys, we have posed the question, What are your companys biggestchallenges related to foreign exchange risk management? In each survey,the most often cited response has been the challenge of understanding,identifying, and quantifying exposures. This response strongly indicates

that the lack of reliable data is why more respondents do not hedge a largerpercentage of their balance sheet exposures.

Approximately whatpercent of your companys

balance sheet positions aretypically hedged?

Percent hedged

Less than

to

to

More than



Maturities of balance sheet hedges

When entering balance sheet hedges, of respondents say that they hedgewith maturities of three months or less, an outcome unchanged from . Short-

term hedges are much more likely to be used by public and larger companies. Forexample, of public companies hedge with maturities of three months or less,while private companies responded at a rate for the same measure. Similarly, of companies with revenues in excess of million annually use hedgeswith maturities of three months or less, whereas of smaller companies hedgewith these maturities. Our inference is that public companies with larger revenueshave more robust methodologies for capturing exposures, allowing them to userelatively short-term hedging programs that are adjusted frequently to true-uphedges to exposures to neutralize the risk of balance sheet exposures.

Balance sheet hedge instruments

With regard to hedging instruments, of companies hedging balance sheet

exposures use forward contracts. This outcome is consistent with the objectiveof using a derivative that secures the value of a known and booked exposure,protecting against FX losses while equally giving up the potential for FX gains. Inaddition to forward contracts, of respondents acknowledged using some formof an option-based derivative or forward contract alternative to hedge this exposure.This outcome is marginally higher than the result when used somealternative to a forward contract hedge.

As we found in past surveys, further analysis indicates that companies that useother derivatives as an alternative to forward contracts for hedging balance sheetpositions tend to be private and small revenue companies versus public, largerevenue companies. Specifically, of private companies reported using a hedgeother than a forward, while only of public companies did so. Since more private

companies in the survey are described by our smaller categorization, the outcomeis reinforced by that metric. Only of large revenue companies report usingoptions for this exposure, while of small revenue companies did.

These results reinforce our conclusion that smaller, private companies are less likelyto be constrained in their use of derivatives compared to larger, public companies.This may reflect that the decision-making process in a smaller company is moreefficient when managerial consensus is easier to achieve. It is also noteworthy thatmany respondents expressed in their qualitative challenges that explaining hedgesand financial reporting to management and the international network is a difficulttask. In such an environment, the relative simplicity of a forward contract may wellreflect the path of least resistance for risk management.

Hedge instruments balance sheet hedges

What is the typicalmaturity of your balance

sheet hedges?

Forward contracts

Option collars

Participating forwards

Cross-currency swaps

Purchased options

Forward extras

32% of respondents use at

least one option-based

derivative or forward

contract alternative to hedge

balance sheet exposures.}

Hedge horizon

month or less

Between and months

Between and

months

More than

months



Hedge accounting election for balance sheet hedges

In , of respondents that hedge balance sheet exposure indicated thatthey elect hedge accounting. This result compares to in and in . These outcomes confirm that a minority of companies elect hedgeaccounting under FAS for hedges of booked foreign currency monetaryassets and liabilities.

This outcome is consistent with our experience for this aspect of financialreporting. Most foreign currency monetary assets and liabilities held on thebalance sheet are trade related, and we believe that hedge accounting forhedges of these exposures is generally an unnecessary election under FAS .

The basic accounting guidance under FAS (ASC ) and FAS dictatesthat the P&L remeasurement of both the underlying foreign currency balancesheet position and the off-setting hedge are reflected on a current basis inthe income statement in the FX P&L line. The symmetrical remeasurementtreatment of the underlying exposure and hedge means that FX P&L isnaturally off-set, eliminating the need for a hedge accounting election.

Given this fact pattern, we are surprised that nearly a third of respondentscontinue to elect hedge accounting. We believe that despite its existence forten years, FAS is still often misunderstood and not applied uniformlythroughout the financial reporting industry.



Hedging practices: Forecasted transactions

We now turn to analyzing hedging practices with respect to forecastedtransactions. The logic of the survey assumed that the of respondents whoacknowledged that they have exposure to foreign currency trade accounts

receivable and payable also have exposure to forecasted foreign exchangetransactions representing future revenues and expenses. While it is possiblethat there are exceptions to this assumption, for most companies, positionsthat arise from trade transactions are likely to be ongoing and represent futureeconomic exposures. Thus, for every company with trade-related balance sheetpositions, we sought further detail around the nature of those exposures.

The first major metric to observe is that of the that fell into the categoryabove, acknowledged that they hedged these future foreign currencyrevenues and expenses. This outcome continues a declining trend of activityfor this exposure as revealed by our three surveys. From the , , and surveys, the outcome for hedging forecasted transactions has been ,, and now , respectively. From to , this decline in hedging

activity was the most notable trend we observed.

We concluded in that the economic environment for most companies hadbeen very difficult due to the uncertainties of operating in a global recession.The unwillingness of an additional of respondents in to hedgeforecasted transactions as compared to the survey was symptomatic oftheir hesitancy to enter into hedge transactions when the underlying positionsthemselves were subject to doubt due to the faltering economy. The similarityof s result as compared to suggests that there continues to be ahangover from the recession that results in hesitancy to hedge forecastedtransactions. It seems certain that only a strengthening global economy willrestore corporate confidence to the point where levels of hedging will approachwhat we observed before the financial crisis in .

Percent of forecasted transactions hedged

Against this general pattern of decline for hedging forecasted transactions, thepatterns of the percentage of forecasts hedged did not change dramatically.Those hedging or less remained exactly the same as the prior surveysat . The next quartiles of to and to groupings reflectedsmall changes that were not statistically significant. Finally, ofrespondents hedge or more of their forecasted transactions.

Percent hedged

Less than

to

to

More than

Approximately whatpercent of your companysforcasted transactions aretypically hedged?



Maturities of forecasted transactions

In response to the question about what is the longest period for which hedgesof forecasted transactions are placed, the results are notably similar from all

three surveys. Responses for each formed a roughly symmetrical distributionaround the twelve-month period, where , , and of respondentsreplied that it was the longest period for which they placed hedges for, , and , respectively. As we have observed throughout oursurveys, this result indicates that many companies plan around a twelve-month cycle, either capturing a full year at once in their planning and hedgeimplementation, or maintaining hedges with a rolling, four-quarter horizon.

As a whole, of respondents who hedge forecasted transactions usederivatives with maturities of twelve months or longer. This outcome isremarkably stable when compared to prior surveys, which reported and in and , respectively. This pattern is even more strikingin light of the fact it has persisted despite an overall fall in the number of

companies hedging forecasted transactions.

What is the longest timeperiod for which you hedge

forecasted foreign currencyrevenues or expenses?

Maximum hedge horizon

months or less

months

months

months

months

years

More than

years



Layered hedge program for forecasted transactions

In a related response, of respondents who manage forecasted transactionsalso employ a layered hedge program. The comparable number in

was . In , it was . This response confirms our belief that manycompanies hedge different percentages of forecasted transactions for differenttime periods, adjusting the hedge amounts (typically to a higher percentage)through time as forecasts become more reliable. The practice was moreprevalent among public () and larger companies (). Comparablenumbers for private companies and those with sales of less than millionwere and , respectively.

Forecasted transaction hedge instruments

Forward contracts continue to be used by nearly all respondents () forhedging forecasted transactions. Of all respondents, also use some form ofan option-based derivative or forward contract alternative for managing these

exposures. This result was in and in . While not a dramatictrend, the successive declines in the use of options during the four-year span ofthe three surveys do suggest a change in risk management behavior.

Hedge instruments forecasted transactions

Forward contracts

}Option collars

Purchased options

Participating forwards

Cross-currency swaps

Forward extras

38% of respondents use at

least one option-based

derivative or forwardcontract equivalent to hedge

forecasted transactions.

To some degree, the reduced reliance on options may go hand in hand withthe reduced activity for hedging forecasted transactions. In the same mannerin which uncertainty about forecasts has curtailed overall hedging activity,corporations may be backing away from options solutions that are moredifficult to explain. Forward contract hedges are easier to understand sincethey do not require a cash outlay and their ultimate payoff is easily described.

An unfortunate outcome of the financial crisis precipitated by the collapse ofthe housing market is that in certain contexts, the term derivatives carriesa somewhat negative connotation. Consequently, corporations may be shyingaway from hedging instruments other than the most basic forward contract.

This is somewhat ironic, since the inherent qualities of option hedges oftenaddress the problem of uncertain forecasts by avoiding the creation ofcontingent liabilities. A contingent liability results from the necessity toabsorb a loss on a hedging instrument when the underlying transaction failsto materialize as a natural offset. Since forward contracts have an all-or-nothing outcome at settlement, they are most subject to the risk of creating



a contingent liability. At , the percentage of companies using options forhedging forecasted transactions is not that much different from the percentageusing them for hedging balance sheet positions (). Previous data had

suggested that options were more likely to be used for hedging forecastedtransactions than balance sheet positions.

Forecasted transactions inherently extend further into the future and areconsequently more likely to be affected by substantial foreign exchangemarket movements. By their very nature, option-based hedges are meantto provide rate protection while allowing the underlying exposures tobenefit from subsequent favorable FX rate movements. While this benefit isundoubtedly appreciated by many hedgers, the overall conclusion to be drawnis that options usage is embraced by roughly a third of our respondents across

all their exposures.

Hedge accounting election for forecasted transactions

Of the companies that hedge forecasted transactions, elect hedgeaccounting under FAS . This is a modest decrease from when saidthey elected hedge accounting and comparable to the outcome of .Public companies, at a rate, are more likely to employ hedge accountingthan private companies at a rate. Also, of larger revenue companieselect hedge accounting, while of smaller revenue companies do so.

The preponderance of public companies electing hedge accounting can beeasily explained. Due to the intense scrutiny around their earnings releases,public companies are typically more concerned about reported earnings andearnings per share results on a quarter by quarter basis. Hedge accountingallows the P&L impact of hedges meant to cover future periods of activityto be recognized in earnings in the same period in which the underlyinghedged transactions occur. This accounting treatment avoids the potential forundesirable income statement volatility from the mark-to-market of derivativestargeted for future periods while still protecting the economic impact offoreign exchange exposure.

Having said that, it is equally notable that an increasing number of publiccompanies choose not to elect hedge accounting while still pursuing theeconomic benefits of hedging forecasted transactions that expose the companyto risk. The outcome of public companies electing hedge accountingfor compares to in and in . Importantly, thisoutcome highlights the fact that hedge accounting is always an election, nota requirement. The trend also indicates that increasingly, public companiesappear to have decided that the rigors of pursuing hedge accounting are notworth the effort, or that the exposures themselves are not sufficiently materialas to justify the practice.

When electing hedge accounting, companies rely most heavily on theiraccounting or audit firm for assistance, with a response rate. Bankingpartners are called upon but at a declining rate. Some indicated relianceon banks in . In , that number slipped to . Third party vendorsoftware is garnering an increasing market share, growing to ofrespondents in from in . Internal software solutions have hit aplateau at of responses.

Hedge accounting elected

forecasted transactions

Public

Private

Hedge accounting elected

forecasted transactions

Million

Million



Translated net income from foreign subsidiaries

and net investments in foreign subsidiaries

In contrast to fairly widespread hedging practices for transactional exposures,a decided minority of respondents acknowledged hedging either translated netincome from foreign subsidiaries or their net investment exposures in foreignsubsidiaries. Only of respondents with foreign subsidiaries stated that theyhedge the translation of net income. The of respondents who indicated theyhedge net equity exposure in foreign subs represents a noteworthy increasefrom , when only said they did so.

The survey attempted to measure the materiality of exposure to foreign netincome. Fourteen percent of respondents said that more than of theirrevenues were sourced in foreign currency, and said that more than ofexpenses were in foreign currency. When the threshold is changed to include or more of revenues and expenses, the numbers jump to and ,

respectively. Thus, the exposure is consequential.

The relative scarcity of hedging for this exposure is mostly attributable tothe prohibition of a hedge accounting election for the translation of foreignsubsidiary net income. Hedging future net income without the benefit of hedgeaccounting creates the possibility of introducing unwanted volatility to theincome statement on an interim basis. Consequently, in an earnings drivenmarket, companies are cautious about protecting this exposure, even thoughour work with a multitude of companies reveals that many would like to do so.

The relative scarcity of hedging the translation of net investment or netequity exposure is similarly an earnings related phenomenon. The translationof a foreign currency functional subsidiarys net equity is captured in the

cumulative translation adjustment (CTA) in other comprehensive income(OCI) in the equity section of the balance sheet. Since the translation does notaffect earnings, it does not receive priority from a risk management viewpoint.

This is an area of risk management where the general level of activity reflectedin the survey should not be confused with a best practice in the marketplace.Hedging a net investment exposure can provide numerous benefits and isgenerally undertaken for highly tactical, special situations, such as foreigndivestitures and dividend payments. The ability to transact hedges to protectforeign investments should not be underestimated in crafting an effective riskmanagement policy.



Additional risk management practices

Accounting conventions

Accounting can be an important driver of risk management practices. Despiteseemingly well-defined rules in the accounting literature, our experience

is that day-to-day practice varies widely among companies with respectto certain accounting conventions. To probe on that point, we asked thequestion, What accounting convention do you use to record foreign currencydenominated revenues and expenses? Of particular interest to us was the factthat indicated they use the prior month-end spot rate. This method offersconsiderable advantages when implementing cash flow hedge accounting forforecasted transactions. While not specifically spelled out in the literature, itspresence represents the extent to which common practice can establish thelegitimacy of an accounting convention.

Accounting convention used - booking rate

Average rate for

the month

Daily spot rate

Prior month-end

spot rate

Other

Risk management approach

The survey asked respondents to identify a style of risk management thatmost closely matched their current practices. The three styles with percentageresponses were as follows:

Systematic risk management:

Hedging a fixed amount of forecasted foreign currency transactions over aspecific time period at regular intervals using specific hedge instruments.

Active hedging: 36%

Discretionar y hedging of forecasted foreign currency transactions based onmarket conditions, that allows for extending the hedge horizon, changingtargeted percentage amounts or discretion in the hedge instrument.

Dynamic hedging: 9% Using discretion not only when initiating hedges, but also during the life of

the hedge.

Comparing the results of the three surveys, no dramatic shifts have occurredfrom year to year. Some modest growth in active hedging and a similar smallcontraction in systematic risk management have occurred. We note that ofrespondents allow for some discretion with respect to amounts, time periods,and hedge instruments, but only a small number allow for discretion duringthe life of the hedge.



Providing a budget for hedging

The survey inquired whether companies provide a budget for expenses relatedto purchasing options for hedging activities. A minority of respondents,

, replied affirmatively. The overall rate in was . This year, ofpublic companies say they provide a budget for options, while only ofprivate companies do so. The relative infrequency of providing a budget forpurchasing options reveals that the concept of insurance to protect againsthighly unpredictable and volatile exchange rate movements has yet to gaina strong foothold among the corporate community. This result is consistentwith the restrained use of options in general for hedging both balance sheetpositions and forecasted transactions identified earlier in the summary.

Centralized risk management

A large percentage of companies () manage risk on a centralized basis.The data was quite uniform across all respondents, with of public

companies and of private companies stating that they managed FXrisk on a centralized basis. In this instance, the prevalence of centralizedrisk management might well be identified as a best practice from a riskcontrol standpoint. Other data indicates that centralized risk managementis a somewhat greater challenge for public companies than private ones dueto the breadth of their operations. Ninety-four percent of public companiesresponded that they have an international presence through foreignsubsidiaries, while only of private companies are similarly exposed.



Biggest challenges related to FX risk management

As in previous surveys, respondents were asked the question, What are yourcompanys biggest challenges related to foreign exchange risk management?The responses from all three surveys have been uncannily similar, both withrespect to how they echoed the same general themes, as well as the number ofresponses for each category. The comments are summarized below, in order ofthose most often mentioned:

Accuracy and timeliness of exposures and forecasted transactions

By far, the most often cited challenges reflected this theme. This theme camefrom of respondents more than twice the next most often mentionedchallenge. The responses expressed frustration with an inability to obtaincompany-wide data in a timely fashion. Similarly, obtaining accurate forecastsfrom business units was a challenge. Responses in this area reflect the ongoingneed for more effective systems to deal with capturing exposures, and/orbetter integration of already existing systems, such as ERP applications, whichmay be currently under-utilized for this purpose.

Market volatility, when to hedge, and using the proper strategy

Next most often, at a rate, respondents cited problems with marketvolatility and the challenge of selecting the proper hedging strategy at theproper time. As recent market events have demonstrated, volatility has to betaken as a constant that will not cooperate with a wish for a stable internationaloperating environment. Given the range of flexibility that derivatives providefor hedging solutions, difficulty with choosing the proper strategy indicates afundamental uncertainty about what economic outcomes are desired. Usuallywhen the financial objective is well-defined, the choice of a hedging derivativebecomes clear.

Approvals, communications, and internal resources

A number of responses are best captured by this broad summary item, oftenreflecting the challenges of explaining risk management initiatives, obtainingapprovals from senior management and directors, as well as gatheringconsensus about appropriate objectives from international subsidiaries.To a large degree, this response echoes the earlier finding that only ofrespondents have a formal risk management policy. Having a policy in placecan help alleviate this problem by ensuring that a company has well-defined,common goals for risk management. Similarly, many respondents indicatedthey would like to become more active risk managers, but lack the resources tofully implement more extensive programs.

Hedge accounting and compliance

In , this was the third most often identified challenge, but in , it hasslipped to fourth place with a response rate. Comments in this area citedthe ongoing challenge of proper accounting and disclosure for derivatives andhedging activities, both in the FAS and IAS environments. Much of thesurvey data suggests that accounting is such a hurdle that it is a clear dis-incentive for implementing hedge programs that in the absence of burdensomehedge accounting regulations would be regarded as economically desirable.


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Summary and conclusion

The Wells Fargo Foreign Exchange Risk Management Practices Surveyrepresents an effort to identify risk management practices from a broadcross-section of our customer base. In this years survey, we observed many

interesting patterns that reflect the dynamics of current market conditionsand that often reinforce the behaviors that became apparent in our priorsurveys from and . The breadth of respondents now compiledfrom the three surveys and the similarity of results from the prior yearsprovide a robust measure of how firms are managing risks in the currentchallenging environment. We hope that this analysis generates ideas forfurther consideration in your organization as you pursue more effective riskmanagement practices. We welcome any additional feedback and inquiry thatthis survey summary may inspire.

Contact us

For additional information about our risk management solutions, contact yourlocal Wells Fargo Foreign Exchange Specialist:

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Legal disclosures

Some of the information or opinions stated in this survey may have been obtained or developed byWells Fargo from sources outside Wells Fargo. In such cases, Wells Fargo believes the information oropinions to be reliable. However, Wells Fargo will not have independently confirmed the reliabilityof such information or opinions and does not guarantee their accuracy or completeness or thereliability of their sources. The information and opinions in this survey, whether or not they wereobtained or developed from outside sources, may not be appropriate for, or applicable to, some or anyof your activities or circumstances. As a result, Wells Fargo makes no express or implied promises,commitments, guarantees, representations or warranties with respect to any of the information oropinions in this survey, including, without limitation, any express or implied warranty of fitness fora particular purpose. In providing the information and opinions in this survey, Wells Fargo is notgiving you any economic, tax, accounting, legal or regulatory advice or recommendations, and isnot acting in a fiduciary relationship with you. Wells Fargo strongly recommends that you seek yourown independent professional economic, tax, accounting, legal and regulatory advice before using oracting on such information or opinions.

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